Key interest rate slashed to 27-year low Discount rate sett at 3.5%

December 21, 1991|By Thomas Easton | Thomas Easton,New York Bureau of The Sun

NEW YORK -- Will another interest rate cut provide the gusto to refloat a stagnant economy?

The Federal Reserve Board yesterday decided to give it its best shot.

In response to a continuing stream of bad news on business conditions, the Fed slashed the discount rate from 4.5 percent to 3.5 percent, the sixth cut this year in the interest the Fed charges member banks for loans.

The 22 percent change in the trend-setting rate is the largest in U.S. central bank history, said Cary Leahey, an economist at Shearson Lehman Brothers.

The Fed also abandoned a long-held policy of not commenting on its actions and predicted in an accompanying release that the way had been paved for "sustained economic expansion."

The move by the Fed brought the discount rate back to where it last stood in 1964 and triggered a series of other rate cuts that collectively brought key borrowing costs back to levels not witnessed for a generation.

Within minutes of the Fed's move, several major New York and California banks reduced their prime rates from 7.5 percent to 6.5 percent and others were expected to follow. The last time the prime was so low was briefly in 1977, before inflation became a household word in the United States.

Banks use the prime rate as a basis for calculating loans to businesses and for determining many types of fixed and adjustable-rate consumer loans.

The rate also reflects what banks pay on savings accounts and certificates of deposit.

The immediate beneficiaries of the prime rate cut will be major businesses that have established relationships with banks and can borrow directly in the financial markets through commercial paper and longer-term notes.

Questions remain about how soon, and to what extent, the lowerborrowing costs will reach non-corporate businesses.

"This rate cut will be enough if the banks pass it on to small business but there is no indication of whether they will," said Richard Stuckey, chief economist with Du Pont, in Wilmington, Del.

Similarly, rates on credit card and home equity debt have declined only lately, and marginally, in response to prior moves by the Fed, as the nation's many weakened lenders have attempted to cover waves of defaults by maintaining large margins on good loans.

There were indications both on Thursday and yesterday, however, that the rates are being passed on to the housing market. Yesterday long-term fixed-rate mortgages had fallen to a 17-year low of 8.5 percent, down from 8.75 percent earlier in the week and almost 10 percent this summer, said Robert Van Order, an economist at the Federal Home Loan Mortgage Corp.

Mr. Van Order said the rate for mortgages would probably decline to 8.25 percent early next week. Meanwhile, teaser rates for the first year of variable rates, tracked only since 1983, are at all-time lows of just above 6 percent and could very well fall another full percentage point soon, he said.

"This has certainly got to help the housing market," Mr. Van Order said, but his enthusiasm about the most recent declines was only muted, characterizing them as "nice, not earth shattering," he said.

Added Mark Obrinsky, senior economist at the Federal National Mortgage Corp., "Will this cause a boom? Probably not. It will not lay to rest all the fears about the housing market, but it will surely help ensure modest gains during the next three to six months until the economy revives."

The Fed's dramatic move surprised and lifted equity and credit markets. In the last few days, traders and analysts had concluded that the central bank would delay any further cut for several weeks.

After the the Fed's action, rates on longer-term debt declined fractionally, suggesting diminished fear about resurgent inflation, and rates on 3-month Treasury Bills fell to 3.72 percent, the lowest level in 20 years.

Meanwhile, stock prices soared, with the Dow Jones industrial average closing up 20.12 points at 2,934.48 on extremely active trading.

That enthusiasm may take months to reach Main Street. For besieged retailers, it will almost certainly not be felt this year. "When you are dealing with interest rates you are dealing with debt and it's hard to see how an extra percent should stimulate buying this late in the Christmas buying season," said Richard Karfunkle, of Econoviews International Inc.